When determining whether to refinance multiple loans, a "Blended Average" (aka "Weighted Average") between interest rates is a great place to start. Oftentimes, Homeowners fall in love with their 1st Mortgage, but turn a blind eye to the interest rate on their 2nd mortgage and/or credit cards when considering a debt consolidation mortgage refinance.
A simple example is as follows:
- $200,000 balance
- 4.000% Interest Rate
- $200,000 balance
- 8.000% Interest Rate
In looking at the above scenario, we can easily calculate that the Blended Average Interest Rate (aka Weighted Average Interest Rate) is actually 6.000%. Therefore if current market rates were 5.000% to consolidate these 2 mortgages, it would actually be a good idea to at least consider this option (depending on how long the Homeowner intended on keeping these loans, the property, etc.).
The challenge from a loan origination perspective however, is helping the Homeowner/Borrower understand that they are not simply replacing a 4.000% rate for a 5.000% rate (which would not be prudent), but instead, replacing a 6.000% blended average interest rate (aka weighted average interest rate) of 6.000% with a 5.000% rate (which makes more sense).
Of course, we do not typically get such easy scenarios to analyze, which requires us to understand how to calculate a blended average interest rate (aka weighted average interest rate). Below is a random scenario involving numbers which are harder to calculate with the naked eye, and the formula in which to use to solve this equation. Regardless of whether the interest rates shown below are consistent with current rates at the time you read this article, I recommend you focus on the math involved (as interest rates constantly fluctuate).
- $180,000 balance
- 7.250% Interest Rate
- $39,000 balance
- 13.750% Interest Rate
In looking at the above scenario, it is nearly impossible to calculate the blended average interest rate (aka weighted average interest rate) with the naked eye. Therefore, I will elaborate the mathematical equation to calculate these averages below:
180,000 (1) + 39,000 (2) = 219,000 (A)
39,000 (2) divided by 219,000 = 0.18 (C)
13.750 - 7.250 = 6.500 (B)
6.500 (B) x 0.18 (C) = 1.170
1.170 + 7.250 = 8.420
Blended Average Interest Rate (aka Weighted Average Interest Rate) = 8.420%
As of the time this article is being published (1/25/2019), many Homeowners have taken advantage of low interest rates and locked in a 30 year mortgage within the last few years. While everyone has their own specific timing for locking in their rates (along with differing qualifying parameters at the time the loan was acquired), I can reasonably assign an estimated average interest rate of +/- 4.250% on a 1st mortgage to a significant amount of Homeowners nationwide.
That said, the Prime Index (which most Home Equity Lines of Credit aka HELOC's are tied to) is at 5.500% and predicted to increase this year according to most analysts. Most HELOC's have a margin that is lumped on to the Prime Index before the actual interest rate the Homeowner/Borrower pays is calculated. For example, a 0.500% margin with today's 5.500% Prime Index would equate to a "fully indexed rate" of 6.000%. As this number trends higher, anyone carrying a high balance on their HELOC might want to be mindful of the Weighted Average Interest Rate (aka Blended Average Interest Rate) they are paying (especially since many HELOC's are permitted to increase to as much as 18.000% according to the fine print located on most Promissory Notes for the HELOC's which have been acquired in recent years).
I am always happy to help Homeowners/Borrowers and/or the professionals who serve these fine folks whenever desired. The best thing about mathematics is that numbers don't lie (you just have to know how to calculate them)!